Differences in Prices and Price Risk across Alternative Marketing Arrangements Used in the Fed Cattle Industry

Information on prices and price risk differences across marketing arrangements aids fed cattle producers in making choices about marketing methods. As part of the congressionally mandated Livestock and Meat Marketing Study, we investigated fed cattle price and price risk differences across marketing arrangements. The analysis uses data representing cattle purchased by 29 large beef packing plants from October 2002 through March 2005. Results indicate that marketing agreements offered the best tradeoff between price level and price risk. Forward contracts had the lowest average yet highly volatile prices. Auction barn prices were higher than other methods but also the most volatile.

In 2003, Congress allocated funds to conduct a broad study of the effects of alternative marketing arrangements (AMAs) in the livestock and meat industries. AMAs that result in captive supplies of livestock by packers (i.e., control or ownership of livestock more than 14 days prior to slaughter) have raised particular concerns for many industry participants. The study was completed in early 2007, and the results are being used in discussions about policy changes that are needed to address whether use of particular methods of procuring livestock by packers has adverse effects on the livestock and meat industries. As part of analyzing the broad range of economic effects of AMAs, we investigated how prices and price risk vary across AMAs (Muth et al., 2005, 2007).

In this article, price risk is defined to mean the variances of prices across AMAs when controlling for the characteristics of the cattle lot and plant-specific effects.1 Information on differences in prices and price risk increases transparency in the market and may improve market efficiency. Our study results help explain why different producers and packers use different AMAs.

The primary types of marketing arrangements used for sales of fed cattle to packers can be categorized as cash market arrangements and AMAs. Cash market arrangements include:

* auction barn sales, including video and electronic auction sales;

* use of dealers and brokers; and

* direct trade, which is an individual negotiation between a buyer and seller.

In contrast, AMAs include:

* forward contracts for the future purchase of a specified quantity of cattle two or more weeks in the future,

* marketing agreements for the future purchase of cattle under a long-term ongoing arrangement, and

* packer ownership in which the packer owns the cattle two or more weeks prior to slaughter.

In addition to these key types of arrangements, the producer can own a small number of cattle, can custom slaughter, and can market the resulting beef products. Prices under most cash market arrangements are determined immediately through bidding or negotiation. In contrast, prices under forward contracts and marketing agreements and some direct trade transactions are based on some type of formula. Prices under packer ownership are based on an internal transfer pricing method, which is often established through a publicly reported market price (Muth et al., 2007).

In theory, risk-averse cattle producers may be willing to accept lower prices for cattle under an AMA, all else equal, because participation in an AMA ensures market access and reduces a number of uncertainties, including whether a buyer is available to purchase cattle when they are ready for slaughter. Conversely, beef packers may be willing to pay higher prices for cattle under AMAs because AMAs ensure they will have cattle supplies needed to run the plant at a higher capacity utilization rate and they will have the necessary quality of cattle to meet buyer requirements for beef products. In some cases, however, the transactions costs involved in negotiating and setting up AMAs, particularly for smaller producers, may prevent market participants from entering into AMAs. …

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